Fiscal Decentralization, Economic Growth, and Democratic Governance

The goal of this paper is to review the state of our knowledge in the economics literature on the causal relationship between fiscal decentralization and economic growth and democratic governance, whether these relationships are uni-directional or bi-directional, and to what extent there appear to exist synergies or pre-conditions between fiscal decentralization, on the one hand, and economic growth and democratic governance, on the other.

Little systematic empirical research has been dedicated to testing the strength of the bi-directional links between fiscal decentralization and democratic governance. At the present time, we have little knowledge about whether fiscal decentralization is preceded by the emergence of democratic institutions, whether fiscal decentralization encourages the establishment of local democratic institutions, or whether fiscal decentralization and subnational democratic governance occur at the same time. What we know about these issues is based on case studies and conjectures and observations from particular country experiences. The information base on decentralization and governance has been limited because case studies of the fiscal decentralization systems in particular countries often pay little attention to governance issues.

There are strong reasons a priori to argue that there should be a symbiotic relationship between fiscal decentralization and democratic governance. Explicitly, and more often implicitly, democratic governance is widely acknowledged in the economics literature as a necessary condition for effective fiscal decentralization. But clearly, there is wide consensus that the relationship also works the other way. Greater fiscal decentralization, especially the devolution or delegation of tax and financing and spending powers to subnational governments promotes democratic governance through representation and accountability.